ZERVOS: The Fed Is Risking An Inflation Disaster, And There Will Only Be One Place To Hide

David Zervos

[credit provider=”Bloomberg TV”]

Jefferies’ economist David Zervos is back in a new note, which takes stock of developments at the Fed and the Bank of Japan.The Fed, of course, recently adopted Evans Rule, which indicates that tightening won’t occur until unemployment gets to around 6.5%, or inflation expectations are around 2.5%. The Bank of Japan is expected to see a new round of aggressive policy, thanks to the wishes of incoming Prime Minister Shinzo Abe.

While markets seem to be pretty happy about it all (ESPECIALLY in Japan) Zervos thinks it will end in uncontrollable inflation, like in other past Keynes-inspired experiments.

In his note, he recounts his time at The Fed:

In fact when I first arrived at the Fed in 1991, all the staff PhD economists I met spoke some foreign language – call it MITease. My world of rational expectations and real business cycles had no place at the table. So in order to understand the policy makers, and the people I had lunch with everyday, I had to learn how they see the world, even if it made absolutely no sense.  I can remember vividly debates about the Phillips curve. And to this day I still have no idea how the concept has survived. We had high employment, high inflation and low real growth in 70s – followed by low unemployment, low inflation and high real growth in the 90s. No matter how much you “shift” or “augment” this  flawed curve concept, it just doesn’t work. The fact that the basic Phillips curve notion of trading off inflation for employment is now explicitly built into Fed policy decisions scares me to no end. There has always been a fat tail to higher inflation outcomes with Bernanke at the helm, but upon reflection, last week’s 6.5/2.5 announcement probably made it A LOT fatter!

Bottom line for Zervos: This won’t end pretty, and there’s only one place to hide. The good news is: It’s stocks.

There are no coefficients, no NAIRUs, no Phillips curves and no r-stars. And the rule has summed up Fed behaviour in the post crisis world better than any other. To that end, the only safe place to hide from the guaranteed dilution of the real value of money and debt is in real/hard assets. And if you still believe (like I do) that the business cycle exists, and we will eventually see an upswing in real growth, then the best real asset is physical capital – specifically equity capital. Good luck trading.

See more Zervos at Markit Hub >